Dodd Deals on Derivatives While Volcker Rule Fight Looms

WASHINGTON — After refusing to answer questions for weeks about whether banks should be allowed to continue to operate as swaps dealers, Senate Banking Committee Chairman Chris Dodd quietly filed an amendment Tuesday that would give regulators the power to gut such a proposed ban.

At issue is controversial language by Senate Agriculture Committee Chairman Blanche Lincoln on derivatives that would force banks to spin off their swaps business.

Her provision was rolled into the broader bill by Dodd and has come under intense criticism from federal regulators, who argue the requirement could increase risks to the system, rather than diminish them, by forcing derivatives into less regulated institutions and over seas.

The issue is a prickly one for the White House and Democratic leaders, who have sought to ensure the bill is as tough against Wall Street as possible. Treasury Secretary Tim Geithner has tried to keep a low profile on the issue recently, ducking taking a position on the issue at a congressional hearing while Democratic leaders like Dodd have deferred to Lincoln on the issue.

The amendment Dodd filed Tuesday would alter a provision of the bill banning banks or subsidiaries of bank holding companies from engaging in proprietary trading and specifically address the ban on purchasing, selling or disposing of derivatives. It would require the proposed Financial Stability Oversight Council, which is comprised of banking regulators, to study the impact of the swaps ban within one year of enactment.

After that point, the Treasury secretary could make a written determination to suspend in entirety or in part any section of the prohibition that he found would have a "material adverse impact on the financial markets and the economy of the United States."

In order to allow for the swaps ban to be killed before it goes into effect, the Dodd amendment would pushback the enactment to two years after the reform bill is signed into law.

But the derivatives section of the bill was not the only obstacle to the reform bill.

The offer from Dodd came the same day that Democrats Sens. Carl Levin and Jeff Merkley said Republican objections to their amendment to strengthen the Volker Rule to ban proprietary trading could jeopardize a procedural vote on the broader regulatory reform bill expected Wednesday morning.

The two lawmakers were frustrated the GOP would not allow a vote on their measure.

"I'm here because an outrageous act occurred on the floor of the Senate not but a few minutes ago in which the leader of the Republicans refused to allow the debate on the floor of a major Wall Street reform amendment, the Merkley-Levin amendment," said Merkley in a press conference.

Levin and Merkley said Tuesday that they would be willing to require 60 votes to pass their amendment, a tougher test that would mean it needs at least some Republican support. But the two vowed to oppose moving forward with a cloture vote on the overall bill unless their measure was called up.

Senate Majority Leader Harry Reid has said that he hopes to finalize the bill in the Senate this week and the cloture vote would be the first procedural hurdle to ending debate on the legislation.

"I'm not inclined to vote for cloture if we can't get a vote on this but we are going to try to get a vote on this…it's a very difficult path," said Levin.

Levin said Republicans were doing the bidding of Wall Street by blocking debate on the amendment.

"They reached in here this afternoon to deny us an opportunity to offer an amendment that so far the procedure has not disallowed….. Republican leaders objected, which is a pretty clear showing of a Wall Street hand as to what was going on here," Levin said. "As Sen. Merkley points out whether it's a 60-vote vote or a 50-vote vote, we can accept either. We want our amendment, which is a strong strengthening amendment, to be brought to a vote."

Merkley also defended the provision.

"This is the amendment that says we need to separate high-risk trading from the normal banking structure that takes deposits and makes loans in order to protect the lending system in America," he said. "This is the amendment that says we need to have regulators increase the capital requirements on nonbank financial investment houses so we do not have them pose as much systemic risk."

The senators submitted a revised amendment Tuesday that would provide a longer transition period of five years to comply as opposed to three years.

It would also provide a five-year divestiture period for banks to stop sponsoring and investing in hedge funds and private equity. It would set up a waterfall process to end such activities. For example, after enactment, a bank would be banned from sponsoring or investing in a hedge fund or private equity fund that it did not sponsor or invest in on May 1, 2010. Two years after enactment, the aggregate amount of equity, partnership or other ownership interests in all hedge funds or private equity may not exceed 2% of the Tier 1 capital of the bank. After 5 years, no bank may engage in any of these activities except for illiquid assets.

The Levin amendment implementing the Volcker Rule is stronger than the existing Dodd language. Levin's version would direct the proposed systemic-risk council to conduct a study on the issue, but they would not have as much leeway in how they implemented it. The Levin language would make the Volcker Rule a statutory ban by changing the Bank Holding Company Act.

Dodd successfully fought off an amendment from Sen. Byron Dorgan, D-N.D., that would have banned naked credit-default swaps. The Senate voted 57 to 38 to table the Dorgan amendment, which dispenses with the issue without voting on the substance.

Dodd said some credit default swaps can be beneficial.

"It's not necessarily a bad thing," Dodd said. "In fact it can be very helpful, again in terms of managing volatility and protecting against losses totally unconnected to your activities."

Dodd added he had "concerns" about "accepting the amendment without knowing what the consequences may be, I have to recommend that the amendment be defeated."